I'm reading the excellent "Irrational Exuberance" by Yale Economist Robert Shiller, which came out in 2000 and correctly predicted the stock market crash of the following two years.

He did this by analyzing P/E ratios versus the 10-year future returns in the stock markets around the world. The higher the P/E, the lower the next-decade returns. This makes since, a market with a high P/E offers less E for your P, and thus less upside.

Anyway Shiller provides a scatter chart of P/Es vs. 10-year real future returns for the US Stock market for the period 1881-1989 (1989 is a far as he could go, since he needed 10 years of future data for each point). I drew a trend line through the graph. The formula for the line is about x=y+20. In other words:

At a market P/E of 20, you should expect a 0% real average annual return of your stock investment over the next 10 years. At a P/E of 15, a 5% real return. At a P/E of 10, 10%.

The current P/E of the US market is about 22, so we should expect a -2% real return over the next 10 years. If inflation is 2% or so, expect your stock investment to be exactly where it is now in 2013. Ug.

There are zillions of books out there where the authors take sets of data, reach firm conclusions, and then project those data into the future.

For every 10 such theories, only one proves to be useful. Most are just busy work. They fill the TV screens and newspaper columns with talking heads (so the audience is attracted for the benefit of the advertizers and every body is happy).

There was one in the '80s that claimed that the boom of the '90s was to be caused by demographics as the boomers entered their greatest earnings years--and spent their funds on their grandkids. That would be great for the likes of Disney and Coca-Cola. Now the demographics have turned against them and all is lost.

There was one in the '90s that claimed the stock market would collapse when all the boomers decided to cash in their stocks and retire.

Such works are fun and thought provoking, but I wouldn't rely on them for investment advice. Your crystal ball is probably at least as good as theirs.

Yep, that's true. But what Shiller shows to be historically correct is logically correct as well.

For example, if you're thinking of buying two hot dog stands...each costs $100,000. One generates $5,000 in annual income (PE=20) and one generates $33,000 (PE=3). All things equal, you can make a good guess as to which of these will be worth more in the future.

Per Shiller, when you aren't getting much for your investment (like the first hot dog stand) your future return is limited. While this may not hold in the future, it does make sense, at least to me.

>>There was one in the '90s that claimed the stock market would collapse when all the boomers decided to cash in their stocks and retire.

This theory is alive and well...there was an article a while back on http://www.jeremysiegel.com/ stating that this may indeed happen (barring an uptake in demand for equities from the developing world).

For example, if you're thinking of buying two hot dog stands...each costs $100,000. One generates $5,000 in annual income (PE=20) and one generates $33,000 (PE=3). All things equal, you can make a good guess as to which of these will be worth more in the future.

>>There was one in the '90s that claimed the stock market would collapse when all the boomers decided to cash in their stocks and retire.

Here's where I start getting confused.....It's with the situation where someone buys the hot dog stand with the PE=3, then:

* Reduces labor cost using "sweat equity" rather than employing others.* Eliminates waste with "just in time" delivery.* Reduces operating costs by replacing high-end kosher dogs with smoked generic, eliminates the sun dried tomatos, shops the day old bread store, etc.* Relocates and targets business based on a strategic market study.* Increase in market share both drives up their profitability and reduces the competitor's (the guy with the PE=20 cart)

At the end of the day, when they've brought the PE to a more respectable 18, and dropped their competitor's to 17 in the course of doing so, both put their carts on the market.

Lo and behold, they both find there's a glut of Hot Dog stands for sale because everyone is retiring and Hot Dog carts go for $87.5k!

Just in time hot dog delivery! What a concept. Very Japanese. I hate having to place my order and come back at the end of the week.

True, any company can be ruined with bad management. Maybe a better analogy is a single hot dog stand in Alaska. In summer, everyone's out buying hot dogs and the market value of the stand soars. Every winter people stay in, the hot dog stand is idle, and you couldn't give it away.

Everyone follows the herd and thinks short term, so the stand is never correctly valued. It's worth $100,000 based on cash flows, but its value is $1,000,000 each summer and $10,000 each winter.

So the key to wealth beyond your dreams is to know which season we're in. Warren Buffet thinks we're now in summer:

Another point that needs to be emphasized is that all this discussion applies to all our *current* investments. Most of us, however, will also continue adding money into the market on a regular basis. The magic of DCA is such that all this regularly added money will show a profit even if the indices are at the same level 10 years hence. (Just as a point of reference, I remember reading that if you had continued DCA'ing into the market thru the Great Depression, you would have made a LOT of money by the end.)

In referring to specific studies where one attempts to project future returns on past history I have the following concerns.

First and foremost, the numbers of variables and intangibles in any given situatuion are such that drawing a conclusive outcome to a future event based on like events in history make such a generlization suspect. How would one or several differences in the next decade change the oucome of what appears to be an identical event in the past. While I do agree that the outcome of history do seem to repeat themselfes, the path that got us there are not always the same.

As to the logic of his book; this too can be explained by the fact that he is forecasting based upon the facts that he cares to present and taken in that context one can't argue with him.

I also believe that it is a human desire to quantify and qualify what we do with logic and hard facts. I would not discount the importance of the study of history or of basing one's actions on such studies, but it can be overdone to the point where one believes he has " a system ".

In a nut shell my two cents is.--Read all you can, don't believe all you read.